Payment history is an easy enough term to understand, but what about credit utilization? While you may be familiar with the concept of a credit score and how it’s important to make yours as strong as possible, most people don’t truly understand the key factors that contribute to building and maintaining said score.
There are 5 core factors that credit bureaus take into consideration when calculating your score:
- Payment history (35%)
- Credit Utilization (30%)
- Age of Credit (15%)
- Mix of Credit (10%)
- Credit Inquiries (10%)
Payment history carries the highest percentage and the heaviest weight of the 5; if you pay in full and on time, your score will be higher than someone who’s regularly late/delinquent and only makes the minimum payment.
Age of credit and mix of credit are also fairly easy to understand; the longer your account has been open, the better. Additionally, the more varied the types of credit you have access to – you want a a good mixture installment loans (mortgage, auto, student loans etc) and revolving credit (credit cards) – the stronger your score will be.
Credit inquiries refers to how often hard inquiries are made to the bureau regarding your account. Hard inquiries typically come from potential landlords, employers, and financial institutions considering whether or not to extend more credit to you. You can learn more about credit inquiries and the difference between a soft and a hard inquiry here and here.
Which leaves us with Credit utilization. Coming in at 30% of your score, one of the most important things you can do is understand what credit utilization means and how to use it to your advantage; it can make a huge difference in how likely you are to be approved for a loan and how much interest you’ll be expected to pay.
Credit utilization refers to how much of your available credit you actually use vs how much is left over.
For example, if you have a credit limit on one of your credit cards of $1,000 and your balance is $500, you’ve used exactly half of your available credit and your utilization is 50%
The less available credit you use, the better. The credit bureaus and financial institutions want to know that while you use credit from time to time, you’re not reliant on it (which can be a red flag for potential lenders).
So, using the example above, even if you have $1,000 available to you, having a balance of $900.00 (90% credit utilization rate) is actually worse for your score than if someone else with a limit of $2,000 had a balance of $1,000 (50% credit utilization rate).
Even though the other person technically has more debt than you, they also have a higher credit limit which positively affects their utilization rate.
So, what can you do to improve your credit utilization? Start by doing the math. Figure out exactly how much you can charge to your card each month without going above 30 or 40% of your available credit. If you have multiple credit cards, try to spread your purchases across all of them rather than building up one big balance.
If you’re uncomfortable with the idea of using multiple credit cards, another option is to contact your bank and to get a balance raise. Even just raising your limit from $1,000 to $1,500 significantly increases how much you can comfortably charge to your card each month without any negative repercussions to your credit score.